Janet Yellen’s Awkward Day

There is good reason to hope that Janet Yellen may go on to become one of the great leaders of the Federal Reserve: she’s a first-rate economist, a gifted explicator of complicated concepts, and an experienced hand at navigating Washington. (At her first appearance as Fed chief on Capitol Hill, last month, the Republican senators may not have been eating out of her hands, but they treated her with unusual deference.) In policy terms, she’s on the side of the angels: passionately committed to getting the economy growing and bringing down unemployment, particularly for the long-term jobless, who have been the biggest victims of the Great Recession and its aftermath.

On Wednesday, though, at her first press conference as chairwoman of the Fed, Yellen had an awkward time, conveying a message that she may well not have intended to, and spooking the markets. This may not be a big deal: Alan Greenspan and Ben Bernanke made similar errors in their early days and quickly recovered. But it did indicate some of the challenges Yellen faces in extricating the Fed from the emergency policy actions it has taken during the past five years.

Her first task was to explain a U-turn in the Fed’s communications strategy. In December, 2012, in an effort to keep down long-term interest rates, particularly mortgage rates, the Federal Open Market Committee, a policy-making body that Yellen heads, publicly stated that it wouldn’t even consider raising the short-term interest rate that it sets—the federal funds rate—until the unemployment rate had fallen to 6.5 per cent. At the time, the jobless rate was 7.8 per cent, and the 6.5-per-cent threshold for a possible interest-rate hike seemed a long way off. But unemployment has fallen rapidly in the past year, and the rate is now down to 6.7 per cent. The markets wanted to know what the Fed would do if it reached 6.5 per cent.

Yellen’s answer today was that it almost certainly wouldn’t do anything, but we’d have to trust the judgment of her and her colleagues on it. In place of its firm “forward guidance” regarding the 6.5-per-cent figure, the F.O.M.C. said, in a statement, that its assessment of when to start raising rates would “take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments.” The statement also said that the committee believed that it would be appropriate to maintain its rock-bottom target for the funds rate (between zero and a quarter of one per cent) for “a considerable time” after its policy of quantitative easing—printing money to buy bonds—ends, which, at the current pace of drawdown, is likely to happen in October.

This change in language wasn’t wholly unexpected. However, it caused some confusion. Like most other observers, I initially read it as a dovish document: it appeared to be designed to give Yellen and her colleagues the leeway to keep the funds rate low even well beyond the date when the unemployment rate drops below 6.5 per cent. But the bond markets reacted differently. There was a significant sell-off after the statement was released, and market interest rates rose—indicating a belief among investors that an early rise in the funds rate was more, and not less, likely.

So what, you might say: markets are always bouncing around, and they usually settle down eventually. That’s true, but it matters a great deal to the Fed how investors on Wall Street, and in other financial markets around the globe, interpret its public statements. These days, the primary way that monetary policy works is by influencing expectations about future changes in policy. If bond-market investors believe that a rise in the funds rate is likely to come earlier than they had been expecting, they will be apt to sell now. That can cause an immediate tightening in monetary conditions, which can hit the housing market and other interest-sensitive sectors of the economy. Last summer, Bernanke inadvertently caused a substantial rise in mortgage rates by appearing to suggest that the Fed was already intent on drawing down its asset purchases.

During her press conference, Yellen got the opportunity to explain what the statement really meant, but instead of clarifying the situation she made it worse. She started out well enough, stressing that the change in wording didn’t mean that the policy stance had changed in any way. Issuing forward guidance had served a useful purpose, she insisted. But, as the unemployment rate had fallen faster than expected, it had created uncertainty about what would happen when the threshold was reached. That’s why she and her colleagues had decided to drop the 6.5-per-cent figure and replace it with the “qualitative guidance” that the Fed would consider a much wider range of metrics than simply the unemployment rate. Yellen also pointed to the bit in the statement about keeping rates constant for “a considerable time” after the policy of quantitative easing ends.

That’s where she got into trouble. Ann Saphir, a Reuters reporter, bluntly asked her how long the gap would be between the end of the Fed’s asset purchases and the first interest-rate hike. A more experienced central-bank head would have obfuscated and said something vague: policymakers generally believe it is imperative to leave themselves some discretion. But Yellen again referred to the phrase “considerable period,” saying, “It’s hard to define but, you know, probably means something on the order of around six months.”

To this viewer, it sounded like an offhand comment, but that wasn’t how the markets interpreted it. Six months from October is next April—about a year away. Wall Street hadn’t been expecting a rate change until the second half of 2015 at the earliest. Yellen, inadvertently or not, had changed the timetable—or so it seemed. The stock market, which had recovered a bit after the release of the Fed statement, immediately gapped down. The Dow, which was down about forty points, fell another hundred and fifty points. In the bond markets and the futures markets, prices shifted sharply to reflect the increased likelihood of an interest-rate rise in the spring of next year.

Yellen, although she couldn’t have known of the market reaction, appeared to realize that she had erred. Any decision to raise rates, she stressed, would depend “on what conditions are like” at the time. She and her colleagues would look at how fast the labor market was moving toward full employment, and whether the inflation rate, which has been dangerously low the past couple of years, was moving back toward the Fed’s two-per-cent target. If inflation was persistently running below the target, that would be a good reason to keep the federal funds rate where it was, she added.

These were excellent points, and they added to my impression that Yellen has no intention of raising interest rates until she is entirely convinced that the economy is finally growing normally, or something very close to it. Unfortunately, though, the communications error had been made. On the newswires and on Wall Street, the message was that the Fed is getting ready to start raising rates, not immediately, but within a year or so. Traders had already seized upon a set of economic projections released alongside the F.O.M.C. statement, which appeared to indicate that some members of the committee had slightly raised their interest-rate forecasts since their previous meeting. Yellen, in her answers, tried to downplay these projections, saying that people should focus on the statement itself. But it all added to the selling pressure in the markets.

Once again, this is not the end of the world, and Yellen didn’t do anything wrong. To the contrary, she delivered a cogent and persuasive explanation of why the Fed’s ultra-accommodative interest-rate polices need to be maintained for a considerable time to come: inflation is too low, and there’s lots of slack left in the labor market. But she allowed her message to be garbled, which is something she’ll have to address going forward.

With the gradual pickup in the economy and the drawing down of quantitative easing, Wall Street’s attention is beginning to focus on the eventual normalization of interest-rate policy, and what impact that will have on the markets. An inflection point in policy is a tricky time to be Fed chairman. There’s always a lot of uncertainty—and provisional statements, which are heavily qualified, can be seized upon as firm expressions of policy. Bernanke had his troubles with this last year; it looks like Yellen may experience some of the same problems. Welcome to the hot seat, Madame Chair.

Photograph by Andrew Harrer/Bloomberg/Getty.

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